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COGO...Chinese Firm Knows That Good Is Never Good Enough On Wall Street...

From Investor's Business Daily...
Friday April 28, 7:00 pm ET
Steve Watkins

Chinese companies are beginning to learn the ways of the American investor. For Jeffrey Kang, chief executive of Comtech Group, the lesson is simple: There's no ceiling when it comes to expectations.
Comtech (NasdaqNM:COGO - News), based in Shenzhen, China, designs modules for cell phones and digital gadgets. The company has turned a profit every quarter for 10 straight years. Annual revenue has averaged 63% growth the last five years.

But it's still not enough, Kang says.

"Investors have high-growth expectations," he said. "To keep our revenue growing at 30%, 40% or 50% a year is relatively easy. But our challenge is to show strong margin expansion."

To that end, Comtech has been adding some high-margin businesses. It entered the engineering field in January, when it acquired Huameng Engineering.

The deal put Comtech in the business of providing hardware and software expertise to help companies set up networks. These services are in high demand as China keeps building telecom networks.

"We believe that will be one of our growth drivers," Kang said.

He estimates the Huameng business will carry gross margins of 40% to 50% -- well above Comtech's overall margins of 19%.

The Huameng unit should generate about $10 million in sales this year, says analyst Daniel Amir of WR Hambrecht.

Huameng's main customer is Huawei, China's largest telecom provider. Huawei expects to spend $300 million on outsourced engineering this year, Amir says. That gives Comtech loads of opportunity to win business.

Comtech's relationship with Huawei dates back 10 years, to when Huawei became Comtech's first telecom customer. Adding engineering services to its work with Huawei fits into Comtech's strategy of generating new business with existing clients.

Another recent move was Comtech's November launch of a location-based search product.

The product is added to mobile phones so people can track where users are located. It's used mostly to keep track of children or elderly relatives. China Telecom (NYSE:CHA - News) and China Netcom (NYSE:CN - News) -- two of China's largest cell phone firms -- plan to offer the service this year, Amir says.

The location search business line should yield gross margins of 35% to 40%, says Albert Lee, analyst at Maxim Group. The two new business lines could take Comtech's overall gross margins to the mid-20% range in the next two years, he adds.

Rapid Growth

Comtech entered the digital consumer electronics business a year ago. It makes parts used in the production of digital TVs, set-top boxes, cameras and other high-tech items. The business represents 11% of overall sales.

Companywide sales hit $106 million last year, up 40% from 2004. Earnings for the year rose only 6%, though First Call analysts see stronger growth moving forward. They expect earnings to rise 42% to 51 cents a share this year, then move up 29% to 66 cents in 2007.

Comtech's core business of making modules for cell phones generates half of overall sales. Its telecom equipment business line, which provides designs for wireless and optical network gear, generates 38% of sales.

Margins in these businesses are not that high, however. Kang says he has to make sure the cell phone business doesn't grow too fast.

"That would be good for revenues, but it would drag down our margins," he said.

The business does have potential. On April 20 Comtech got its first major design win for third-generation cell phones when it inked a deal with Huawei. The deal should lead to more third-generation design business, analyst Lee says.

"That should be a harbinger of things to come," he said.

Comtech serves more than 200 customers. This helps give it exposure to all types of high-tech business in China.

"We view ourselves as a proxy to China tech manufacturing," said Hope Ni, Comtech's chief financial officer.

That's a good spot to be in. China's mobile phone subscribers should grow by 8% a year through 2008, Lee says. The number of Internet users is rising 17% a year. Digital TV use also is growing rapidly.

As far as risks go, one is a potential slowdown in China's telecom spending. That would hit Comtech hard, though Kang figures spending will keep climbing until at least the 2008 Beijing Olympics.

Things could slow a bit after that. To help offset the potential loss in business, Kang is eyeing new business lines such as modules for medical devices or energy uses.

"We're always thinking about what's the next fast-growing business in China," Kang said.

http://biz.yahoo.com/ibd/060428/newamer.html?.v=1